I HOLD THIS TRUTH TO BE SELF-EVIDENT, THAT A DEBT CRISIS CANNOT BE RESOLVED WITH MORE DEBT

Friday, March 14, 2008

Yesterday's News

Standard and Poor helped the stockmarket clutch some more straws yesterday by providing a bit of yesterday's news about sub-prime loans. That the market chose to interpret it as it did is indicative of how desperate speculators have become for anything that provides a respite from the incessant drumbeat of terrible economic releases. (It also shows that many of the shorts are still of the "weakish" money variety and scare easily - but this requires a whole other analysis).

The rating agency said that it now estimates sub-prime mortgage loan write-offs will reach $285 billion (up from $265 billion in their previous estimate), but that the end of such hits to bank balance sheets is pretty near.

Well, excuse the colloquialism but.. Duh! The credit contraction has moved well past its sub-prime mortgage starting point and is currently reaching a whole array of other credit instruments from commercial real estate and leveraged buy-out loans, to consumer receivables and credit default swaps. Anyone still discussing sub-primes as "news" might as well announce that "Kennedy Was Shot!!".

What I would like to hear from S&P, instead, is their estimate for everything else. But I'm not holding my breath. They, too, have a business to run and profits to make, so don't expect them to start bad-mouthing customers who can still pay rating fees. As always, such reports will come out only after the customers are clinically dead and fee-less.

By the way, if you view this state of affairs as a "conspiracy" I have to inform you that this is business as usual. The two main ratings agencies, have always shut the barn door after the cows were gone. It's safer that way - unless, of course, you happen to own the cows..

Update: Bear Stearns being funded by JP Morgan and the Fed (!!!) is truly horrible news. Makes lots of other players suspect, too and the credit clamps are tightening fast. Oh, and I wonder what the funding split is Fed/Morgan?..

Update #2: According to Reuters, Morgan is essentially a conduit that will take Bear's collateral and post it to the Fed's discount window. So the Fed is doing 100% of the funding. Oy vey...

36 comments:

eh
said...

By the way, if you view this state of affairs as a "conspiracy" I have to inform you that this is business as usual.

You'd have to be a real Pollyanna at this point not to have at least some suspicions. I mean, in this case (yesterday) just look at the timing: big falls in Asia and Europe, then S&P lets fly some pablum and the market turns around.

As a 'non-weakish' short it is, I must say, not only very frustrating, but also nerve-racking.

I have 2 questions - one of which might lead to my own embarassment but I am willing to take the risk.

#1. A couple topics ago you mentioned that, keeping with your Populist sympathies (I added that - teehee), you felt that employees needed to keep more of their pay and even get their wages increased - by doing so they would have more money to apply to their financial troubles. You mentioned that Demand-side inflation was possible but not probable and worth the risk. But wasn't (isn't) the problem all the entities willing to extend consumers some form of credit and the consumer abusing this offering? Even if you raised the take-home pay of employees wouldn't they still get themselves in debt trouble because easy creditors encourage bad habits (in fact, wouldn't an across the board take-home pay increase encourage consumers to go further in debt because now their income has increased)?

#2. The U.S. has the largest gold Reserves in the world - their gold Reserves (supposedly) is over 70% of their monetary base. As I type that warning flags start popping up but I will continue (I knew this one might make me look bad). With gold over $1000 an ounce why doesn't the U.S. sell a couple thousand tons of gold and get some dollars back - and retire them! The U.S. isn't the only mining country on the map but, given the ramp up of gold stocks, we could replenish some of that gold relatively soon. Given that the world (supposedly) relies more on what our gov't says the Dollar is worth rather than our actual gold backing (fiat fiat fiat) anyway might the U.S. selling some of its gold be a good inflation fighter (and debt decreaser) or am I just being a goofy, nieve M3Anon?

Debt and earned income are diametrically opposite. More income means less debt, under normal conditions, i.e. when lending practices are properly regulated and not predatory and/or so loose as to pose a danger to the entire financial system. I think we are now going to get very tight regulation... so extra income will help all around.

As for selling gold..2.000 tons at today's prices comes to $70 billion. Almost enough for you and I to retire on ;) but hardly enough to make a ripple in the Sea of Dollar.

M3anon said ... "(Hell), you felt that employees needed to keep more of their pay and even get their wages increased "

Hell, I guess I too may have misunderstood you or at least jumped the gun too quickly. I assumed you were suggesting we increase wages by either:1. cutting corporate profits and give some back to the workers

or

2. cutting governement taxes (let workers keep more take home pay).

Would you show me if I am seeing this wrong?... Wouldn't either of these approaches be 'zero-sum', since the first approach just reduces corporate spending (one of the last bastions of R&D in our economy) while the second approach would just increase governement debt (and thereby despoil a future commons to protect today's)?

I guess in the second scenario you could keep government debt flat by offsetting tax cuts with spending decrease, but then you would be back to 'zero-sum' as gains in consumer spending are neutralized by losses in governement spending).

I can't believe the markets are not further down on the Bear collapse, as if there are still a ton of people in denial, or who think the Fed providing non recourse funding to IBs is an ongoing viable economic operation. It really looks at this point, with so many time bombs to still go off, that the Fed is going to end up having to take over the majority of the core financial system. At some point, probably sooner rather than later, the dollar will get killed for this and then all hell will break loose globally.

The ripples take time to spread out. The most significant effects, in my opinion, are going to be in the counterparty trading limits amongst all participants, from inter-bank to big leveraged customers like hedge funds and PE funds.

In this business, if you get cut off from access to credit your are dead. And once the news is out that you can't get any money from anyone other than the Fed, all your customers are going to jump ship ASAP.

I thought this blog was pretty insightful too. "http://interfluidity.powerblogs.com/finance/" One of the brought up there is that the fed is nationalizing Bear Sterns and most likely other banks, but to what extent they do not say. That kind of transparency should be mandatory after the Fed comes to the conclusion they are unwinding the failures safely. An THEN All of those execs should be perp-walked and publicly shamed for their failure.

.Bear Stearns collapsed this week? Well that was too easy. Last summer it began with them, and if IIRC you (HellasIOUs) wrote that it was no real surprise as one of their "hedge" funds jumped latest into the subprime game, at the peak of the housing bubble.

Soon after Bear Stearns, last summer, came BNP Paribas. However we are quite proud, in France, that this bank was not hit (even if I remember an article quoting its boss about uncertainties in counterparty risks...)

I have a question on the 32:1 leverage. Shouldn't the government regulate the leverage level at hedge funds? It appears that there is no regulation at all. So in normal/good years, these guys make a ton of money. During bad years, they "only" lose their capitals and leave a mess for others to clean up (e.g. systemic financial failures.) This looks to me like a rigged game where "heads I win and tails you lose!"

There is a strict limit on individual margin accounts. For example, my broker will never allow me to borrow at 32:1 level. But somehow the same rule does not apply to the accounts of financial institutions / hedge funds?

My point was these hedge funds (e.g LTCM) made a lot of money in good times but when they crashed, they brought down the whole financial system with them. In the early 1900s, it was legal to corner a market and there was no limit on individual margin accounts. But the government got concerned and put in regulations to prevent such abuses. I believe the government need to step in to prevent individuals and financial entities from abusing the market and creating systemic problems. The systemic problems seem to occur too easily/frequently.

Anon, you make very good points and I agree with everything you are saying, AND STILL, you and I are stock owners with positions in the very financial institutions that are lending money to these hedge funds at favorable rates in the first place.

The reality is many investors are lazy, and they somehow believe ownership does not mean responsibility over how companies are manged, which is of course absurd.

Do you own index funds? These funds take passive ownership approaches, meaning they rubber stamping anything management recommends, no matter how absurd the proposal is.

But the reality is management and owners often have a conflict of interest. Ignoring ownership responsibility comes at its own peril. This lazyness is NOT OK.

When we bought ownership positions in these companies (even through index funds) we became owners. We accepted responsibilities for how these companies were managed.

It is absurd to think owning shares in companies means buying a stocks and 'forgetting about it'. Vanguard has done investors a great disservice in this regard, all their marketing to the contrary.

Warren Buffett buys entire companies precisely because he understands owning the whole company is the best way to ensure the company will be managed with integrity and according to his wishes.

When will everyone else recognize this?

So the fact that you and I are treated differently than hedge fund is true, and yet, 'you' and 'I' own the very companies that set these policy.

As you have pointed out, stock holders today have little input on company operations. But government can and should regulate businesses (e.g. car emission.) It may be difficult to regulate them, in this case, but the survival and functioning of our financial markets is far more important.

Free market is good but unregulated free market is disastrous. These abusive and reckless practices by financial entities should be stopped, if possible, by the government before they cause grave damages. They just announced, belatedly, tighter mortgage lending regulations. I think they should also regulate financial leverages. But many key policy makers came from Wall Street... :(

As for the Diebold situation: The next rigged general election will lead to riots. You see, it won't just be the financial system that falls completely apart, government will too when the citizenry wake up to just how utterly corrupt things are, and they will.

Regarding gold, read Jim Sinclair over at jsmineset.com Gold is going to become money though not in the way goldbugs imagine.

Regarding the stock market: It will be down big as March drags on. The bond market will see to that. When the 'trendline from '82 breaks, we are right on it, we will lose a thousand points on the Dow in a day, two at most.

For years i've had these same thoughts as you- the idea that as a shareholder in a company I'm an owner and have a responsibility to monitor with an eagle eye the activites of the management. With precious few exceptions, the managements of publicly traded companies operate them as if they were privately held. Managements make decisions solely based on how those decisions benefit the management- outside shareholders be damned. Corporate governance law is designed to perpetuate this system. Even so, where does one find the time to monitor with due diligence the activites of so many individuals to whom we have entrusted our savings? Moreover, the companies aren't exactly forthcoming if you call them up seeking answers.So I ask myself: has anyone put a gun to my head and forced me to invest in these companies? Well, no, they haven't. It's not as if there aren't other investment options. Commodity ETF's would appear to be one of the better options.

Every day I shake my head in dismay and fret about the future of this country- not some distant future but the immediate future. It seems to all be coming to a head.

Just a curious side note does anyone find it strange that according to a Bloomberg story that 74 of 80 AAA tranches that make up the series of ABX Indexes fall well below the stated credit support needs of both Moody's and S&P? Think about all the hundreds of other AAA trnaches that are in the same situation, yet the rating agencies will not be seen downgrading any of those securities in the next 2 months. Why not you ask? The street can now go to the FED with AAA private label securities and swap them for US Treasuries, however the FED will not take BBB rated securities but they will take it seems BBB securities that are still rated AAA.

Another massive coverup attempt by the street, the FED and the rating agencies. Mark my word, no downgrade of a single AAA private label mortgage security for the next 2 months so the crooks can try and save their firms.

Another massive coverup attempt by the street, the FED and the rating agencies. Mark my word, no downgrade of a single AAA private label mortgage security for the next 2 months so the crooks can try and save their firms.

You are probably correct, but IT WON'T WORK because they are pushing on a string.

all making it incredibly easy for management to control their companies (which is fine) but then subvert company money for purely selfish purposes (which is not)

There are solutions, but no matter what we choose, we are still left with issues of faith and integrity...

1. As lazy investors we could transfer our voting rights to others who we trust and who will watch after our interests (pay them a small fee)-- but we have to trust they will not ultimately subvert our votes to their ends

2. Az Lazy investors we might only invest our money in leadership we have high faith in-- say the Warren Buffetts of the world. But in the end we are trusting them.

3. Or we could be active investors but invest in a much smaller number of companies that we do study closely. Of course, we are trading one risk (loss of diversification) with another (better information about a much smaller number of businesses).

4. We could even do as Anon suggests, where we take a governement regulation approach to the issue. Of course, we will still have to trust the politicians and the regulators they appoint in the end.

No matter what we do, we will always come up against issues of faith/trust in one another and integrity.

And faith/trust, is always easier when we know what kind of character we are dealing with. And this is what large societies have trouble with. We have moved a long way from the small tribal bands on the savannah, where 99.99% of our evolution resided.

Societal cooperation was able to develop in that environment precisely becasue we were in small groups and everyone knew eveything about everyone else-- all necessary to decide who is trustworthy, and who is not. Loss of group cooperation would have meant the difference between life and death. Trust and cooperation were strongly selected.

But today, in our highly mobile society with a strong bend towards protecting privacy (how many people here go under the name anon...?)is is becoming easier and easier to hide our integrity/reputations from the group.

The truth is some of these corporate sleezballs have been known to be sleezballs since they were six years old, only you and I as Joe Six Pack Investor didn't know this as we have no way of learning about their character. The have the right resume (went to Harvard, etc...), but how do we learn about their character?

PS-- please don't get me wrong, I like privacy as much as the next person, and I am all for civil rights, AND we have to recognize that protecting privacy at all costs has its own costs as well.

"In this business, if you get cut off from access to credit you are dead."

And so it goes for the individual tax-paying consumer. We've built societies that inherently require the use of credit in order to make this big blue ball continue to turn.

I'm still trying to figure out why Wall Street borrowing at 32:1 ratios could have ever created a problem of this magnitude - deep sigh and exagerated Seinfeldesque eye roll.

The consumer has a few credit cards maxed out and runs into trouble (we know who created it) and somehow every government official and Wall Street dip$#@! jumps on top of it making the consumer out as being the unwise, uneducated, over-spending idoit that is responsible for the current state of financial crisis.

Investor Boys. . .It's been interesting reading the economic blogs with all the tears being shed over the pending collapse of the economy. What makes you guys any better than the Wall Street scum who thought up the derivatives scam? Didn't they do what investors are supposed to do? You know, make money at every else's expense. Isn't shorting the market really placing bets on the failure of your own society? Sickening. You investors have contributed to the the destruction of the working/middle class by supporting companies that have off-shored our manufacturing base. I suggest you all get real jobs and create some real wealth. Actually, there aren't many jobs to go around. How about learning to grow your own food? Maybe that way some of you won't starve. Now go back to making a quick buck. Time is very short.

In America, you can steal a few percentage points of votes and get away with it. Try stealing 20% of the vote and you go to jail. People just ignore your attempt to rig the vote and they start taking orders from the people that won the election instead of the people you say won the election.Seriously, we have more guns in this country than voters.

A bit off-topic but I hope you won't mind... In the Netherlands we have gone back to paper ballots. Ans another etback for the people who like to digitize verything: the tax people managed to make 730,000 (yes, three-quarters of a million) income tax returns that people had filed on the tax office web site disappear. The assistant minister for fiscal affairs apologized "730,000 times". Last sunday, the weather over here was horrible, and quite a few of the people concerned tried again. The result: the tax office's website went down, but only said so after people had finalized their return. Glad to read that you are also a fan of old-fashioned paper!

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.